The boring problem of bank regulation.

The failure of Silicon Valley Bank exposes a problem in the regulation of America's banks.

This isn't just a concern of bankers. Every American counts on a healthy banking system. There are no bystanders. 

The Fed, FDIC, and Treasury made emergency expansion of the $250,000 limit on bank deposit insurance to deal with the failures of Silicon Valley Bank and Signature Bank. The $250,000 limit was supposedly a way to distinguish between ordinary citizens and presumably-sophisticated depositors. Mom and Pop citizens are understood to be in no position to get constant updates on the quality of a bank's assets. Average citizens just want a safe place to deposit money. Their deposits are insured by the FDIC. However businesses with a deposit float of more than $250,000 are presumed to be sophisticated. They are presumed to be able to evaluate the quality of their bank's loans and internal controls. They are creditors of the bank.

San Jose Spotlight: Depositors lined up to withdraw money from SVB

The presumption is preposterous. No depositor, small or large, without access to the detailed financial records of a bank can know how sound a bank is. Regulators at the San Francisco Fed, with responsibility to oversee the bank, did not understand SVB's problem. The senior management team at the bank surely understood it was falling into danger, but they did not know how to stop it and they didn't advertise the peril. (The CEO was busy selling personal stock in February, however.) When--too late--the bank began scrambling to get new capital to cover their losses, the bank had passed the tipping point. A tweet warned the public to get out now. Depositors got out.

Suspicious and vigilant depositors are a poor way to enforce prudent discipline on banks. Americans should recognize this and adjust. If depositors find something to worry about, it is too late. If a large depositor reveals its concern, it starts a bank run, even if it is a false alarm. Tweets like WITHDRAW YOUR MONEY NOW!!! will cause a bank run. Silicon Valley Bank and Signature Bank were both unusually vulnerable, but not because their loan portfolios were crazy-risky, although SVB's certainly was. Their vulnerability came because they had a depositor mix that was low on insured Mom-and-Pop depositors and high on businesses customers with large deposits at risk. 

The very largest U.S. banks are under requirements to pass "stress tests." They are JPMorgan, Bank of America, Citibank, Wells Fargo, Morgan Stanley, Goldman Sachs, Bank of NY Mellon, and State Street. Had those stress tests been in place for SVB, it would have failed them. They were not in place because semi-large banks lobbied for lower reserve requirements. A Republican-led effort in 2018 rolled back the Dodd-Frank laws, loosening banking regulations. Some Democrats joined in. It looked like an easy vote. Who cares about bank regulations? Loosening regulations made those banks happy. What could go wrong?

When small banks fail depositors of all sizes are made whole not by the FDIC or by taxpayers, but because a larger and healthier bank is willing and able to sweep in and take over, keeping the valuable branches and customers. That works for small and even medium-size banks. But there is a gap in the bank-failure system. Some banks are too large and complicated to be taken over in a weekend, including those large banks that got their regulations loosened, banks like SVB.

What to do? Americans should not be afraid of forcing bank regulations and reserve requirements back onto banks. The Department of Justice should not hesitate to claw back bonuses paid to executives of failed banks. Prosecute people who withheld information. Wealthy white collar malefactors are not afraid of fines. They don't want to be imprisoned. We should not be hesitant to imprison people who commit white collar crime.

It is the nature of banks to maximize profits as much as they can, given the rules. In that sense they are like NFL players. They would do face-mask tackles, except that they are forbidden and the rules are enforced with big penalties. If face-mask tackles were legal, failure to use them would put the team at a competitive disadvantage. Banks want to be profitable in the same way NFL players want to win. Give them the regulations and they will compete within those regulations, if there are serious consequences against the bad actors. Again, I recommend prison. Bankers will think twice.

Why not just let capitalism work its creative destruction? Why bail out anyone, including the depositors? Why not let the whole mess of people at SVB just drink the SVB poison and learn that the government won't interfere? Isn't that capitalism at work?

It is a bad idea because of collateral damage to the innocent. A bank failure causes ripples of damage to bystanders. And damage to them causes damage to their bystanders. It hurts the wrong people the most.

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